The unloved ones: how a value manager sees the banks

August 13, 2017

Caroline Cai: Pzena Investment Management portfolio manager

Value investing is a core strategy for super fund members. It’s about the Rothschilds and Warren Buffett. It’s about Ben Graham, the father of the theory behind value investing. However you carve up history, value investing makes sense. But investing goes in cycles. Where are we now?

According to Caroline Cai, portfolio manager at Pzena Investment Management, we are still coming off the bottom of the value cycle. The ‘FANMAGs’ – big growth tech stocks – have had a resurgence in the last few months. For any value manager, and a lot of other managers, including market-cap index managers, the FANMAG resurgence is a worrying sign. But, at least, value managers know it won’t last.

New York-based Cai, who visited Australia last week, says that value managers, such as Pzena, which has both a Melbourne and Sydney office, are always looking for “self-help opportunities”. By this she means where company management reacts positively to troubling times and unlocks the value which may have been hidden from the rest of the market.

Companies become “unloved” from time to time and those which have reasonably good management can adapt to those periods. Value managers aim to pick those transition times. For Pzena, a deep-value manager which is currently offering a concentrated global strategy to Aussie investors, this means picking a portfolio of about 50 stocks from a universe of about 2000.

For Pzena, named after its founder and CIO, Richard Pzena, financials, such as big regional and global banks, are currently presenting a buying opportunity. Cai says they are still suffering from the “long shadow” of the global financial crisis.

“Financials are interesting for us because of the ‘self-help’ notion, she says. “We are starti9ng to see it in less popular places, such as Japan, where there has been more aggressive restructuring.”

Europe is also offering opportunities, such as with UniCredit, an Italian bank. “What UniCredit did this year, with a capital raising to get rid of its non-performing loans, is not very different from what Citi did in 2009,” Cai says. “The destination is the same but they got there at different speeds.”

But not every bank has “self help” possibilities, she says. For instance, Deutsche Bank, the troubled German retail and investment bank, fails to tick any of Pzena’s boxes for a value purchase.

Cai says Deutsche never amalgamated its back-office technology, notwithstanding a lot of mergers and acquisitions. And the retail banking sector in Germany is very competitive because of the number of community not-for-profit banks.

“It actually takes a lot of work to make a lousy business into a good one,” she says. The broader spectrum of disruption, such as from the fintech start-ups, also needs to be considered.

There are three “essential components” to a bank, in Pzena’s view. They are:

. Risk taking, which is providing credit to wholesale and retail customers, and which fintech advancements can provide better ways to interact with customers or provide an extra distribution channel.

. Deposit taking, where the bank’s government-regulated charter makes for a significant barrier to entry from potential competitors, and

. Payments, where there could be potentially a lot of change, such as through the adoption of blockchain technology, which might present new competition or new productivity gains for the banks.

Pzena sees a subtle change occurring in the market, which still has a wide value spread in terms of pricing. The discount which is attached to uncertainty about future competitive advantages for companies is extremely high, Cai says.

But, for active value managers at least, the trend to passive management and its various forms is a good thing, Cai says. “If managers provide real alpha generation, through their own research, competing against indices of any form should not be difficult.”

David Taylor, Pzena’s Australasian chief executive, says that alpha becomes more important when markets are struggling. “Value spreads are wide today and there’s a dichotomy between loved and unloved stocks,” he says. “The banks as a whole are still unloved.”